Mean-Variance Analysis

AAA

DEFINITION of 'Mean-Variance Analysis'

The process of weighing risk (variance) against expected return. By looking at the expected return and variance of an asset, investors attempt to make more efficient investment choices- seeking the lowest variance for a given expected return, or seeking the highest expected return for a given variance level.

Mean variance analysis is a component of modern portfolio theory, which assumes investors make rational decisions, and that for increased risk they expect a higher return. 

INVESTOPEDIA EXPLAINS 'Mean-Variance Analysis'

There are two major factors in mean variance analysis: variance and expected return. 

  • Variance represents how spread out the data set numbers are, such as the variability in daily or weekly returns of an individual security.
  • The expected return is a subjective probability assessment on the return of the stock. 

If two investments have the same expected return, but one has a lower variance, the one with the lower variance is the better choice.

By combining stocks with different variances and expected returns in a portfolio (diversification), the variance and expected return of the portfolio can be altered as the price moves of one stock may be offset by the price moves of another in the portfolio. 

RELATED TERMS
  1. Smart Beta

    Investment strategies that emphasize the use of alternative weighting ...
  2. Discretionary Investment Management

    A form of investment management in which buy and sell decisions ...
  3. Account Minimum

    The minimum balance required to be maintained in an investment ...
  4. Capital Growth

    The increase in value of an asset or investment over time. It ...
  5. Absolute Percentage Growth

    An increase in the value of an asset or account expressed in ...
  6. Compound Annual Growth Rate - CAGR

    The year-over-year growth rate of an investment over a specified ...
Related Articles
  1. Investing Basics

    Modern Portfolio Theory vs. Behavioral Finance

    Modern portfolio theory and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions ...
  2. Fundamental Analysis

    Calculating Covariance For Stocks

    Learn how to figure out how two stocks might move together in the future by calculating covariance.
  3. Investing Basics

    Diversification: Protecting Portfolios From Mass Destruction

    This investing strategy retains its charm as a protection against random events in the market.
  4. Investing Basics

    Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  5. Personal Finance

    Diversification: It's All About (Asset) Class

    Frustrated stock pickers rejoice - asset class selection is simpler and safer.
  6. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  7. Bonds & Fixed Income

    Does International Investing Really Offer Diversification?

    Historically, international investing has worked out well for investors, but this may no longer be the case.
  8. Economics

    What's the relationship between r squared and beta?

    Learn about the relationship between R-squared and Beta. Explore how the concepts are related and often used in conjunction with portfolio Alpha.
  9. Economics

    What are some limitations of the consumer price index (CPI)?

    Explore some of the basic limitations of the widely used economic indicator, the consumer price index, or CPI, and examine the criticism of its accuracy.
  10. Trading Strategies

    What are common investing mistakes in bear markets?

    Learn why investing in a tumultuous market can be challenging even for the most experienced investors. Avoiding these common mistakes is key in bear markets.

You May Also Like

Hot Definitions
  1. Multiplier Effect

    The expansion of a country's money supply that results from banks being able to lend. The size of the multiplier effect depends ...
  2. Command Economy

    A system where the government, rather than the free market, determines what goods should be produced, how much should be ...
  3. Prospectus

    A formal legal document, which is required by and filed with the Securities and Exchange Commission, that provides details ...
  4. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  5. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  6. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
Trading Center